In the wake of Banco Popular, the European banking sector has suffered its second bank failure in a few weeks.
This time it was two Italian banks from the Veneto region, Banca Popolare di Vicenza and Veneto Banca, whose financial solidity has been under severe pressure for several quarters from numerous and poorly provisioned non-performing loans, which heavily undermined solvency ratios at both banks. This despite repeated interventions by the Atlante fund1.
On Friday 23 June, the ECB said the two Venetian banks were failing or likely to fail2. As these were small-scale non-systemic banks, the ECB’s Single Resolution Board decided to allow the Italian national authorities to wind them up3.
First, shareholders and subordinated bondholders (mainly Tier 2) will take a hit from the cost of winding up the banks and will be hived off into a bad bank with assets drawn from the NPLs of the two banks, following the Banco Espirito Santo model and indicating recovery rates will undoubtedly be meagre. Small individual holders of subordinated debt could seek compensation after the event, but the proportion they can hope to receive is yet unknown.
Second, Intesa Sanpaolo – Italy’s leading bank – is to buy the "healthy" parts of the two banks' balance sheets4 for a notional euro, which means it will get:
- €26.1 bn of healthy loans and €4 bn of performing but risky loans (totalling around 8% of Intesa Sanpaolo’s loan book);
- €8.9 bn of other financial assets;
- €1.9 bn in tax assets;
- €25.8 bn of customer resources (deposits);
- €23 bn in off-balance sheet savings (indirect deposits);
- €11.8 bn of senior debt issued by the two banks;
- 960 branches and around 10,840 employees.
This is capital neutral for Intesa Sanpaolo, as the Italian government will pay around €4.8 bn to cover recapitalisation and restructuring costs (branch closures and redundancies) on the assets acquired and provide a €1.5 bn public guarantee against any legal contingencies resulting from the acquisition. The Italian government has also committed up to €12 bn against potential losses on the newly acquired healthy loan book. Finally, Intesa will be able to transfer any of the performing but risky loans (total of €4 bn) to the bad bank if their quality becomes impaired before 2020.
This resolution to the Venetian bank crisis is in our view good news for the Italian banking sector. First, two non-viable bank balance sheets have finally been cleaned up and transferred to a sounder institution. For the buyer, Intesa, the deal was done on highly advantageous terms without harming solvency ratios. Finally, the senior creditors of the two little banks survive despite everything. This quells fears of contagion, given that many were small individual savers.
The next hurdle in cleaning up the Italian bank sector is Banca Monte dei Paschi di Siena. On 1 June, the European Commission approved a preventative recapitalisation which allows the bank to access state aid and safeguard the interests of senior creditors, while unloading its NPLs to the Atlante fund (negotiations on this point are ongoing). Here again, the subordinated debtholders and shareholders will take a hit, in accordance with European law, as a condition of unlocking state aid.
In light of these latest events, we reaffirm once more our philosophy of taking only premium positions in subordinated debt, as recovery rates in the event of default are near-zero on either Tier 2 or Additional Tier 1 debt. The only subordinated debt we hold is in Intesa Sanpaolo and UniCredit in the La Française AM fund. Both names were boosted yesterday by the action of the European and Italian authorities and their financial strength has been significantly bolstered in recent quarters.
The content of this presentation does not constitute an offer or solicitation to invest, nor investment advice nor a recommendation to make any specific investment. Information, opinions and numerical data are thought to be well-founded and accurate on the day the presentation was written in light of the economic, financial and stock market circumstances at the time and reflect the view at that date of the La Française Group on the markets and their trends.
1 A fund constituted by Italy's leading financial institutions, including UniCredit and Intesa Sanpaolo, to recapitalise struggling banks and buy out their doubtful loans.
2 https://www.bankingsupervision.europa.eu/press/pr/date/2017/html/ssm.pr170623.en.html